EUR/USD: Trade Deal Shifts, Economic Divergence, and 2026 Outlook

The euro’s recent performance against the U.S. dollar has signaled a complex and evolving shift within global currency markets. While its immediate decline following a preliminary trade agreement between the European Union and the United States sparked concern, longer-term projections indicate a potential for significant recovery. The euro experienced a depreciation of over 2%, prompting questions regarding the sustainability of its preceding rally. This immediate market reaction underscores underlying economic divergences and disparate monetary policy trajectories between the two major economic blocs, potentially setting the stage for significant currency revaluations by 2026.

• The euro depreciated over 2% against the dollar immediately following a preliminary EU-US trade agreement.
• The trade deal imposed a 15% tariff base, significantly higher than previous levels, raising concerns for Eurozone economic growth.
• Economic divergence is stark: Eurozone Q2 GDP grew a modest 0.1% (with Germany contracting 0.1%), while the U.S. economy expanded by a robust 3% in the same period.
• Monetary policies are diverging, with the Federal Reserve anticipated to cut rates, whereas the European Central Bank has concluded its rate-hiking cycle.
• Long-term forecasts, notably from Rabobank, project the euro could recover to $1.20 against the dollar by spring 2026, contingent on Fed policy.

Immediate Market Reaction and Economic Pressures

The euro’s swift depreciation subsequent to the trade pact underscores a prevailing market sentiment, which, for some analysts, suggests a temporary exhaustion of the currency’s prior upward momentum. Jane Foley, Head of FX Strategy at Rabobank, described the agreement as a “reality check.” While the deal successfully averted a more severe 30% tariff scenario, the imposed 15% base rate stands significantly higher than previous levels, igniting concerns regarding its potential impact on Eurozone growth. This apprehension is further amplified by recent economic data: the Eurozone’s Gross Domestic Product (GDP) grew by a mere 0.1% in the second quarter, and Germany’s economy, despite expectations for fiscal stimulus, contracted by 0.1%.

In stark contrast, the United States recorded robust 3% GDP growth during the same period, signaling a strong recovery from earlier contractions. This significant economic disparity, according to Foley, provides a fundamental rationale for the euro’s current correction against the dollar, a currency that had experienced aggressive gains in preceding months. Matthew Ryan, a market strategist at Ebury, corroborates this perspective, asserting that the trade agreement “hurts more than benefits the European economy.” This dynamic has contributed to the dollar’s recent rebound, particularly given its “oversold” status following a challenging preceding half-year.

Divergent Monetary Policies and Future Outlook

The contrasting monetary policy trajectories of the Federal Reserve (Fed) and the European Central Bank (ECB) further complicate the currency outlook. While the Fed has largely maintained stable interest rates, a significant internal disagreement has emerged, with two of its eleven members voting for rate cuts—marking the most notable dissent since 1993. Market expectations currently project a 0.25 percentage point rate cut by the Fed before the end of the year, followed by two additional reductions in the first half of 2026. Conversely, the ECB appears to have concluded its aggressive rate-hiking cycle, maintaining its terminal rate at 2%.

Despite the immediate headwinds facing the euro, longer-term projections suggest a potential for significant recovery. Rabobank, for instance, forecasts the euro could reach $1.20 against the dollar by spring 2026, a level not observed in four years. This projection is contingent on the Fed adopting a more accommodative monetary stance and would represent a notable appreciation from current levels, which hover around $1.14. Holger Schmieding, Chief Economist at Berenberg, anticipates a resumption of the dollar’s downtrend in 2026. He attributes this primarily to the structural growth differential that he believes favors Europe over the U.S. While the dollar benefits from the Fed’s cautious approach and eased trade tensions in the short term, Schmieding cautions that underlying structural risks—including rising protectionism, unsustainable fiscal policies, and immigration restrictions—continue to persist.

From a strategic standpoint, Goldman Sachs suggests that the newly implemented 15% “reciprocal” tariff base could diminish U.S. competitiveness and potentially dampen foreign demand for dollar-denominated assets. This scenario, coupled with a potentially less attractive dollar and a euro bolstered by expansive fiscal policies within the Eurozone, could indeed trigger a significant rebalancing in the global foreign exchange market by 2026. The key determinants for this shift will undoubtedly be the evolving expectations surrounding interest rates and the relative growth trajectories of both major economies.